Notes explaining aqa elasticity for economics

Long explanations of what is needed for elasticity

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  • Created on: 02-06-11 12:47
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The usefulness of price elasticity for producers
Firms can use the concept of price elasticity of demand (PED) to predict the following:
The effect of a change in price on the total revenue & expenditure on a product.
The likely price volatility in a market following unexpected changes in supply ­ this is important
for commodity producers who may suffer big price movements from time to time.
The effect of a change in a government indirect tax on price and quantity demanded and also
whether the business is able to pass on some or all of the tax onto the consumer.
Information on the price elasticity of demand can be used by a business as part of a policy of
price discrimination. This is where a monopoly supplier decides to charge different prices for
the same product to different segments of the market e.g. peak and off peak rail travel or yield
management by many of our domestic and international airlines.
Useful applications of price elasticity of demand and supply
Elasticity of demand and supply is tested in virtually every area of the AS economics syllabus. The key is
to understand the various factors that determine the responsiveness of consumers and producers to
changes in price. The elasticity will affect the ways in which price and output will change in a market.
And elasticity is also significant in determining some of the effects of changes in government policy when
the state chooses to intervene in the price mechanism.
Some relevant issues that directly use elasticity of demand and supply include:
Taxation: The effects of indirect taxes and subsidies on the level of demand and output in a
market e.g. the effectiveness of the congestion charge in reducing road congestion or the impact
of higher duties on cigarettes on the demand for tobacco and associated externality effects
Changes in the exchange rate: The impact of changes in the exchange rate on the demand for
exports and imports
Exploiting monopoly power in a market: The extent to which a firm or firms with monopoly
power can raise prices in markets to extract consumer surplus and turn it into extra profit
(producer surplus)
Government intervention in the market: The effects of the government introducing a
minimum price (price floor) or maximum price (price ceiling) into a market
Elasticity of demand and supply also affects the operation of the price mechanism as a means of
rationing scarce goods and services among competing uses and in determining how producers
respond to the incentive of a higher market price.

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How do businesses make use of estimates of income elasticity of demand?
Knowledge of income elasticity of demand for different products helps firms predict the effect of a
business cycle on sales. All countries experience a business cycle where actual GDP moves up and
down in a regular pattern causing booms and slowdowns or perhaps a recession. The business cycle
means incomes rise and fall.…read more

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Substitutes: With substitute goods such as brands of cereal or washing powder, an increase in the price
of one good will lead to an increase in demand for the rival product. Cross price elasticity for two
substitutes will be positive. For example, in recent years, the prices of new cars have been either falling or
relatively flat. Data on price indices for new cars and second hand cars is shown in the chart below.…read more

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Source: GFK report on Consumer Spending Trends, July 2006…read more


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